It’ll Cost You

Sanjib Saha

IT’S IRONIC THAT WE often shortchange retirement savings during the first half of our working lives, because that’s when we can buy future retirement dollars at a huge discount—thanks to investment compounding.

How can we hammer home this point? My proposal: We should adopt a simple mental math rule that allows us to weigh today’s spending against future retirement dollars. That brings me to my ”6 to 2 times 200” rule. The rule covers five age groups: early 20s, late 20s, early 30s, late 30s and early 40s.

The first part of the rule—the “6 to 2” part—gives the compounding factor for each age group. For instance, the compounding factor is six times if you’re in your early 20s, five times if you’re in your late 20s, and so on. As you grow older and enter the next age group, the compounding factor drops by one. What does all this mean? Each $1 spent by folks in their early 20s means at least $6 less in retirement spending. Similarly, $1 spent in your early 40s means at least $2 less in retirement.

Admittedly, the rule is only an approximation. Still, with any luck, it’ll help us to pause before spending. For instance, it will make a 27-year-old realize that switching to that shiny new $1,000 iPhone could cost as much as $5,000 in retirement spending. Is it worth effectively spending $5,000 on a new phone?

Our 27-year-old may still decide to switch to the new iPhone. After all, we all make bad spending decisions and we usually get away with it, provided the bad decisions aren’t too frequent or too costly. Instead, the real damage often comes from recurring expenses—the monthly magazine that no one reads, the extra property taxes for the bigger-than-needed house and countless similar items.

This is where the second part of the rule—the “times 200” part—comes into the picture. Suppose our 27-year-old is looking at an unlimited data plan that costs $25 a month extra. To figure out how much this means in lost retirement spending, we would multiply the $25 by five, which is the age factor, and then by 200, because it’s a recurring monthly expense. Result: Opting for the data plan means giving up perhaps $25,000 of retirement spending.

To put it another way: $1 of recurring monthly expenses over your working life dents your ultimate nest egg by $1,200 if you’re in your early 20s, $1,000 if you’re in your late 20s, $800 if you’re in your early 30s, and so on.

Is the “6 to 2 times 200” rule accurate? Some argue that the cost of a daily latte for a 22-year-old amounts to $1 million. My rule puts it at a relatively modest $120,000, assuming each latte costs $3.33. Why the big difference? I’m using an inflation-adjusted “real” investment return of 5%, so the numbers aren’t distorted by inflation. That means that, if the rule says $10 spent every month is costing you $10,000 in retirement, those two numbers have similar purchasing power. But however you do the calculation, the lesson is clear: A recurring expense is far costlier than it appears.

Curious about where the numbers come from? They assume you work until around age 60. The compounding factor—the “6 to 2” part—comes from eyeballing the future value of a dollar invested for various time periods. The lump sum conversion of the monthly recurring payments—the “times 200” part of the rule—is the aggregate present value of the payment streams involved.

As you might gather, I’m not swearing that the “6 to 2 times 200” rule gives the exact right answer. But precision isn’t the point. Instead, the goal is simplicity, so the rule is easy both to remember and apply. The idea: Get ourselves to pause before we spend—and ponder how much an item is truly costing us.

A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles were Mind the TrapA Rich Life and Cost of Living. Self-taught in investment and financial planning, Sanjib is passionate about raising financial literacy and enjoys helping others with their finances. Earlier this year, he passed the Series 65 licensing exam as a non-industry candidate. 

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